Earning some money without needing to work more hours sounds good to me. That is one of the reasons I invest in the stock market. Over time, I find that the dividends from shares can add up to a useful source of extra income.
Rather than thinking about short-term cash flows, I would aim to build this income in coming years. If I wanted to target £200 each month in dividends, even if I had never bought a single share before, here is how I would go about it.
Steady and regular
The first step in my approach consists of getting some money I can use to buy shares.
I do not need to start with much. But buying shares will take money, so I would get into a regular habit of putting aside a set amount to invest.
Whether that is £10 a month, £100 a week, or some other amount, would depend on my personal financial circumstances. I think it is important to set a target that is realistic and I can hopefully achieve.
I would put the money into a share-dealing account, or Stocks and Shares ISA.
Finding shares to buy
My next move would be hunt for shares to buy and then hold for the long term.
Not all companies pay dividends. Even when they do, they can be cut, or cancelled. Companies including Persimmon and Direct Line have both reduced, or eliminated, their payouts in the past year.
So I would not just look at a company’s current dividend yield, which is the annual payout as a percentage of the share purchase price.
Rather, I would focus on finding companies I feel could generate free cash flow to fund dividends far into the future.
For example, I expect Unilever with its broad range of premium consumer brands can make profits for years to come. That could translate into dividends – and extra income for Unilever shareholders.
Building a portfolio
So why do I not own Unilever in my portfolio? There are risks in its business model, such as inflation eroding profit margins. But I still like it as a business.
The price tag though, looks less attractive to me.
It also means Unilever shares currently yield 3.4%. If I was building a second income, I think I could buy into companies with a higher yield than that while still sticking to blue-chip names.
With an eye on risks, I would diversify my portfolio across a range of shares. If I managed to earn an average yield of 5%, I would need to invest £48,000 to hit my monthly extra income target of £200 on average.
I would not start with that sum, but build to it through regular contributions. So the amount of time it would take me to hit my goal for extra income would depend on how much money I invest each month, as well as my choice of dividend shares.
